THE EFFECT OF AUDIT QUALITY ON FINANCIAL PERFORMANCE OF NIGERIA DEPOSIT BANKS

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CHAPTER ONE

INTRODUCTION

1.1   Background of the Study                                                                                                           

Since the audit forum was established, one of its key aims has been to promote confidence in financial reporting. The statutory audit can reinforce confidence because auditors are expected to provide an external, objective opinion on the preparation and presentation of financial statements. Auditors need to be independent in the opinions they express, while the work they have to do to form their opinions is highly dependent on, and the real world and may become particularly challenging in some national environments.

Financial statements are prepared to provide useful information in making business and economic decisions (Dogan, Coskun & Celik, 2007). This information is important for the users, as they use the statements to assess the financial condition and performance of the related companies (Ahmed & Hossain, 2010). Farouk and Hassan (2014) stated that the financial statement audit is a monitoring mechanism that helps reduce information asymmetry and protect the interests of the various stakeholders by providing reasonable assurance that the management’s financial statements are free from material misstatements. Okaro, Okafor & Ofoegbu (2015) posit that quality audit promotes the credibility of financial statements.

According to International Auditing and Assurance Standards Board (IAASB); there have been a number of attempts to define “audit quality” in the past. However, none has resulted in a definition that has achieved universal recognition and acceptance. Audit quality is, in essence, a complex and multi-related concept.

The processes and tasks that a quality audit involves can be managed using a wide variety of software and self-assessment tools. Some of these relate specially to quality in terms of fitness for purpose and conformance to standards, while others relate to quality costs or, more accurately, to the cost of poor quality. In analyzing quality costs, a cost of quality audit can be applied across any financial institution rather than just to assembly processes.

Audit quality is ultimately about the purpose of the audit. The measure of audit quality is whether the auditor has given an appropriate audit opinion, as evidenced, perhaps, by the absence of audit failures. This view emphasizes audit judgment. It is predicated on the assumption that auditors will detect material misstatements through the application of judgment and process and that they will report them. A measure of audit quality is whether auditors have done all that is required of them.

According to DeAngelo (1981) defined audit quality as; the probability that a given auditor will both discover and report a breach in the client’s accounting system. The probability of discovering a breach depends on the auditor’s technical capabilities to detect any material misstatement and the probability of reporting the error depends on the auditor’s independence.

According to Koh, Choi and Woo (2014) most companies and managers lack the accounting knowledge and resource to create a suitable financial statement. In fact, many banks rely on the auditor to make the financial statement and take advice from the auditor before making any accounting decision. Therefore, auditors indirectly affect the financial statement prior to doing their job (Ilaboya & Ohiokha, 2014). In this circumstance, companies have a high level of reliance on auditors when they make an accounting decision or make a financial statement. A high level of reliance on the auditor implies that the auditor highly affects the quality of the financial statements (Koh, Choi& Woo, 2014). Insufficient or inappropriate audit evidence may lead to wrong calculations and this may affect the quality of the report (Ilaboya & Ohiokha, 2014).

According to KPMG, there is no universally definition of the terms. At the least, quality external audit service would include a rigorous audit, with an appropriate degree of professional skepticism, conducted in compliance with the applicable standards.

Audit can also be used for safety purposes. Evans & Parker, (2008) describe auditing as one of the most powerful safety monitoring techniques and ‘an effective way to avoid instance and significant slowing deteriorating conditions’, especially when the auditing focuses not just on compliance but effectiveness.

Financial performance is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues. It is also used as a general measure of a firm’s overall financial health over a given period of time, and can be used to compare similar firms across the same industry or to compare industries or sectors in aggregation.

There are many different ways to measure financial performance, but all measures should be taken in aggregation. Such as revenue from operations, operating income or cash flow from operations can be used, as well as total unit sales. Furthermore, the analyst or investor may wish to look deeper into the financial statements and look for margin growth rates or any declining debt.

There are different stakeholders in deposit banks, including trade creditors, public users, investors, employees and management. Each group has its own interest in tracking financial performance of banks. Analysts learn about financial performance from data published also known as annual report.

Banks are economic institutions that facilitate economic growth and development by mobilizing savings from the surplus unit and channeling them to deficit unit for productive investments. They also provide the payment and settlement system and implement monetary policy of government; it is on this strength that Sanusi (2012) considers banks in the financial system as the central nervous system of the economy.

1.2    Statement of the Problem

The audit failure in the world, especially in Nigeria, has brought great disappointment to the user of financial report. The problem has been traced to long-term of audit firm tenure which has been traced to creative accounting. In Nigeria audit setting, the challenge of audit tenure and audit quality reporting has not attracted much testable study beyond mere anecdotal opinions Mgbame, et al (2012). In view of these studies, auditor tenure has become the focus of much debate. The production of audit quality report is seen to foster confidence in financial reports by the users of those reports. Investors in particular tend to place better trust in financial statements that are audited; as the expected independence of the auditor boots the assurance that important investment decisions can be made on those statements. The increased confidence of these set of financial users tend to attract the inflow of capital which has the long-run effect of creating growth and development in the business environment.

However, lack of efficiency on the part of management could lead to disorganized financial statements. These financial statements ordinarily do not show the true state of affairs and financial position of the deposit banks and hence, could threaten the decisions of the prospective investors. Unfavorable results on investment would reduce the credibility of the financial statements; which would in turn reduce the level of capital flow, thereby de-generating the state of the business environment. The burden therefore rests on the auditors to address these issues through efficient and effective execution of the audit assignment, and the outcome production of a quality report. The study therefore investigates the factors that could affect the quality of the audit assignment, and analyzes the existence and degree of relationships between these factors and the achievement of high audit quality in the Nigeria deposit banks (International Journal of Academic Research in Accounting, Finance and Management Sciences).

Theoretically, the auditor is expected to be independent of the management staff of the company being audited. However, a number of factors like familiarity, threat of replacement of an auditor and the provision of management advisory services appear to impair auditor’s independence. Concerns have been expressed about the conflict of interest between the statutory role of the auditor and the other services it may undertake for a client (UK House of Common Treasury Committee, 2008).

1.3    Objective of the Study

The main objective of this study is to ascertain the effects of audit quality on financial performance of deposit banks in the Nigeria. The specific objectives include to:

1. determine the effect of audit quality on Return On Assets of deposit banks in Nigeria.
2. ascertain the effect of audit quality on Earnings Per Share of deposit banks in Nigeria.

iii.         determine the effect of audit quality on net profit margin of deposit banks in Nigeria.

1. determine the influence of audit quality on Dividend Per Share of deposit banks in Nigeria.

1.4    Research Questions

1. To what extent does audit quality affect Return On Assets of listed deposit banks in Nigeria?
2. To what extent does audit quality affect Earnings Per Share of Nigeria banks?

III.         To what extent does audit quality affect net profit margin on listed deposit banks in Nigeria?

1. To what extent is the influence of audit quality on Dividend Per Share on deposit banks in Nigeria?

1.5    Hypotheses

H₀1: Audit quality has no significant effect on Return On Assets of deposit banks in Nigeria.

H₀2: There is no significant relationship between audit quality and Earnings Per Share of deposit banks in Nigeria

H₀3: Audit quality has no significant effect on net profit margin of deposit banks in Nigeria

H₀4: Audit quality has no significant effect on dividend per share of deposit banks in Nigeria.

1.6    Scope of the Study

This study covers on the effect of audit quality on financial performance of Nigeria deposit banks and their activities for the period (2005-2014). The study made use of secondary data. Also this study shall be limited to investigating the relationship between Audit Quality (independent variable) and the dependent variable (Financial Performance).

We shall limit our study sample to three (5) quoted banks in the Nigeria stock exchange from a population of twenty-five (24) banks in Nigeria as at the time of this work. The selected quoted banks under study are: Diamond Bank of Nigeria; Zenith Bank Plc and Guarantee Trust Bank (GTB) Wema Bank PLC, United Bank for Africa (UBA).

1.7   Significance of Study

This study will enlighten bankers, government, investors and researchers on the effect of audit quality on financial performance of deposit banks in Nigeria.

It helps bank operators and officials on what to focus on in order to grow the financial performance of various institutions. This study also encourages government to develop appropriate capacities and put in place adequate structures to guide and monitor excellent performance and safety of the financial system. It serves as knowledge to researchers on financial analysis and enable the researcher show that return on assets, earnings per share, working capital, net profit margin and dividend per share constitutes major determinants of the financial performance of deposit banks. The findings of this research guides investors on key parameters to be adequately considered in undertaking investments prepositions in financial institutions.

1.8Operationalization of Variables

Y=f(X)

Y=Dependent variable and

X=Independent variable

Y will represent financial performance of deposit banks.

X will represent audit quality.

Which means Financial Performance is a function of Audit Quality. Financial performance will either increase or decrease depending on the performance of the deposit banks.

Mathematically, it is represented as;

FPDB=f (AQ).

All the sub-variables can be written in small x

X=f (x1, x2, x3, x4)

x1= audit report lag

x2= audit fees

x3= audit tenure

x4= audit firm size

Y=f (y1, y2, y3, y4, y5)

y1= return on assets

y2= earnings per share

y3= net profit margin

y4= dividend per share

y1 (FPDB) = f (x1) ROA————-eqn 1

y2 (FPDB) = f (x2) EPS————–eqn 2

y3 (FPDB) = f(x3) NPM————-eqn 3

y4 (FPDB) = f(x4) DPS————–eqn 4

Where;

ROA means Return On Assets

EPS means Earnings Per Share

NPM means Net Profit Margin

DPS means Dividend Per Share

FPDB means Financial Performance of Deposit Banks

1.9    Operational Definition of Terms

Audit quality: it is the process of systematic examination of a quality system carried out by an internal or external quality auditor or an audit team. It is an important part of an organization’s quality management.

Quality audits are performed at predefined time intervals and ensure that the institution has clearly defined internal system monitoring procedures linked to effective action. This can help determine if the organization complies with the defined quality system processes and can involve procedural or results-based assessment criteria.

Financial performance: it is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues. This term is also used as a general measure of a firm’s overall financial health over a given period of time, and can be used to compare similar firms across the same industry or industries in aggregation. Items such as revenue from operations, operating income or cash flow from operations can be used, as well as total unit sales.

Return on assets (ROA): is a financial ratio that shows the percentage of profit a company or bank earns in relation to its overall resources. It is commonly defined as a net income divided by total assets. Net income is derived from the income statement of the bank or company and is the profit after tax. The assets are read from the balance sheet and include cash and cash-equivalent items such as receivables, inventories, capital equipment as depreciated, and the value of property such as patents. ROA is a ratio but usually presented as a percentage.

Mathematically;

ROA= Net Income/Total Assets.

Earnings per share (EPS): is the portion of a company’s profit allocated to each share of common stock. It serves as an indicator of a company’s profitability. The balance sheet and income statement are used to find the weighted average number of common shares, dividends paid on preferred stock (if any), and the net income or earnings.

Mathematically; it can be calculated as:

EPS = Net Income – Preferred Dividends/Weighted Average common Shares.

Net profit margin: it is the percentage of revenue remaining after all operating expenses, interest, taxes and preferred stock dividends have been deducted from a company’s total revenue.

Mathematically;

Net profit margin (NPM) = Net profit/total revenue

Net profit = total revenue – total expenses

Dividend per share: it is the sum of declared dividends issued by a company for every ordinary share outstanding. The figure is calculated by dividing the total dividends paid out by a business, including interim dividends, over a period of time by the number of outstanding ordinary shares issued.

It is an important metric to investors because the amount a firm pays out in dividends directly translates to income for the shareholder, and the dividend per share is the most straightforward figure an investor can use to calculate his/her dividend payments from owning shares of a stock over time.

Mathematically;

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